Retirement Planning: To Roth or Not to Roth

So Mrs. Brows and I spent last Saturday working on our finances, fixing our budget for this year, and trying to predict the future.  In the process, we started talking about our retirement savings strategies.

I introduced her to Suze Orman’s Retirement Roadmap which Suze presented on her show last November or December.  In it, she details what she thinks people in every decade of their life (20s, 30s, 40s, etc) should be doing now to save for retirement.

My ears especially perked up when I heard it, because she started with people in their 20’s. Good financial planning or investment advice and strategies for people in their 20’s is practically non-existent out there.  I’ve searched the web pretty extensively, and very few people ever get past a blanket “it’s best to start early because look how much more you can potentially make.”  Well, the problem is, they never get into exactly HOW we make that much more with time on our side.  Instead, they just focus on those in their 40s or 50s who have higher net worths and screw ups to deal with.

Anyways… Suze’s advice: for those in your 20s who have access to a 401k with a matching contribution, contribute to your 401k only up to the match, and then open a Roth IRA and contribute up to the $5000/yr max there.

What’s the difference, you ask?  The 401k is an employee sponsored account/program for retirement that saves and invests your money pre-tax, thus making your taxable income lower.  This is great for high-income people who are trying to jump into a lower tax bracket by contributing to retirement.  There are great incentives to do a 401k, the foremost of which is an employer match (a.k.a. FREE MONEY).  Always take the free money, I say.

The Roth IRA is an individual account (not owned by the company) that takes money you’ve already been taxed on and invests it for retirement.  The earnings and the corpus of money is not taxed as income when you withdraw it during retirement.

I crunched on this advice in the back of my mind for a few months, and it started making more sense:

  1. 401k + Roth IRA provides diversification.  Whether you think taxes will be higher in the future or lower, you just might be right.  🙂  The best way to protect against an unsure future is to diversify, and having both a 401k and Roth will give you the ability to draw from each pool at the right time, or preserve the pool if you need to.  Plus, having some of your income tax-free will lower your overall taxable income during retirement, which has the potential to be high if you started saving in your early 20s for retirement anyways.
  2. More trading options with a Roth IRA.  The money in your Roth can usually be invested in a lot wider variety of investments.  It can also be quickly turned back into cash, if you need.
  3. Fewer penalties with Roth. You can withdraw the money from a Roth much easier than a 401k, and without the 10% IRS penalty.

The downside?

A Roth will require more care and attention than a 401k.  You will usually not have the ability to do paycheck deductions for a Roth, so you just have to be SURE than when you reduce your 401k contribution to the match, you really go through with making the Roth contribution.  Otherwise, you just gave yourself a raise at a great cost to your retirement.

We also found out that even if one spouse works, you can have a Roth IRA in each person’s name and contribute up to $5000 in each, giving you a combined after-tax savings of up to $10,000/year.

More info:

3 thoughts on “Retirement Planning: To Roth or Not to Roth”

  1. I’m doing exactly this right now. My 401k match was 5%/4%, but with everyone’s greatest excuse for screwing the workers (i.e., the economy), they’ve cut it down to a 2%/2% match. So I cut down my contribution, and instead put that money into a Roth. I’ve got my Roth through Sharebuilder, which I like quite a bit.

    Great post!

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